Dividends can create rising yields for investors

Big blue-chip companies such as General Electric and Corning are exciting not just because of their businesses, but also because of their dividends.

If you buy into a healthy company when its dividend yield (annual dividend divided by share price) is 3 percent, you’re likely to get that payout every year, regardless of what happens to the stock price. (And today, such a yield easily tops many alternatives, such as bank accounts or CDs.)

Here’s something investors rarely consider. Imagine you bought 10 shares of a company for $100 each, and it pays a respectable 3 percent dividend. With a $1,000 investment, that’s an annual payout of $30.

But dividends aren’t static and permanent. Healthy companies raise them regularly. A few years down the line, perhaps Wanton is trading at $200 per share. Imagine that its dividend yield is still 3 percent, as its dividend has been gradually raised to $6 per share. Note that $6 is a 3 percent yield for anyone buying the stock at $200, but since you bought it at $100, to you it’s effectively a 6 percent yield.

Decades pass. Your initial 10 shares have split and become 100 shares, each worth $90 now. Your initial $1,000 investment is now valued at $9,000. The yield is still 3 percent, paying $2.70 per share, so your 100 shares deliver a whopping $270 per year. Think about this. You’re earning $270 on a $1,000 investment.

That’s effectively 27 percent per year (and growing) — without even counting any stock-price appreciation. The yield on your initial investment has gone from 3 percent to 27 percent, because you just hung on to a growing company. Even if the stock price drops, you’re still likely to get that 27 percent payout — unless the firm falls on really hard times.

By holding on to many great dividend-paying companies, you can enjoy rising dividend yields over time.

Ask the Fool

Q: What’s “the Dow”?

A: It’s the Dow Jones Industrial Average, created in 1896 by Charles Dow, who also established The Wall Street Journal.

The roster often goes many years without any changes. In 2008, Altria, Honeywell and AIG gave way to Chevron, Bank of America and Kraft Foods. In 2012, though, after Kraft spun off part of its business, it was replaced by UnitedHealth. In 2009, Citigroup and General Motors were replaced by Cisco Systems and Travelers. Some major companies, such as Apple and Google, have not yet made the list.

The Motley Fool take

Four Promising Utility Stocks: Utility companies are great portfolio stabilizers and income generators. Here are four to consider:

Exelon (NYSE: EXC), recently with a dividend yield near 7 percent and annual revenue near $33 billion, is one of America’s largest energy producers. It’s also America’s largest nuclear-energy company. With natural gas prices low lately, nuclear power has been losing ground, but we may also see a push for nuclear reactor subsidies in an attempt to rid the U.S. of its reliance on foreign oil.

American Water Works (NYSE: AWK), founded in 1886, recently sported a dividend yield of 2.6 percent. It’s the largest publicly traded water and wastewater utility company in the United States, relying on everything from cost-cutting to IT-improvements to increase its profits. It’s begun offering services to (controversial) gas-fracking operations, which might boost profits.

Southwest Gas (NYSE: SWX), recently yielding 2.7 percent, has upped its dividend by an annual average of about 8 percent over the past five years. It offers natural gas service to the southwestern U.S.

National Grid (NYSE: NGG), recently yielding more than 5 percent, serves up electricity to the northeastern U.S. and the United Kingdom. Thus, it offers geographic diversification. It also has been investing in alternative energies.

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